Rapid Growth vs. Capital Efficiency
For early-stage SaaS companies, rapid growth vs. capital efficiency is a constant tug of war.
The dilemma has become quite acute these days since there’s been an expansion of available capital from VCs to fund high growth (and unprofitable) companies. This “going for the grand slam” strategy is easier for the VC to pursue (investing in a portfolio hoping that one grand slam pays for many strike-outs) than for the management team (the team that spends years of sweat and tears on the very personal one-time chance of making it).
The more capital available from VCs, the more capital is raised, the more capital is burnt, the more likely you and your investors won’t be satisfied.
His point of view is that companies burning capital in pursuit of hyper-growth or market share “land-grab” are copping-out. CEOs should be driving their teams to operate within the company’s capital means and should be working very hard to uncover efficiencies and differentiation that would drive growth and efficiency in as much unison as possible. Spending your way into growth is very risky, and can result in reduced equity value for your shareholders.
The ‘get big quick’ strategy is risky when a company is young and there is no foundation for scaling. Also, having too many people influencing a fragile balance of strategy and customer feedback can be a disaster for an early-stage company — i.e. too many cooks ruin the soup. Scaling with raised capital is good when you have figured out all the operational details and have a clear shot a begin the category leader. Otherwise, it indeed reduces value for all shareholders.
Clearly, there are many companies that have successfully adopted the spend-your-way-to-growth strategy. Slack and Hubspot come to mind. But there are thousands of other companies that have tried to play that game and failed miserably. You just don’t hear about them as loudly as the ones that are successful.
On the other hand, one of the best examples of companies that have so very successfully shunned the high burn model is Atlassian. Founded in 2002 in Australia, the founders of Atlassian were uber-committed to building a company without raising VC money. They designed a product that sold itself, to the point where they did not hire salespeople for many of the early years. Instead, they opted for hiring support personnel. Atlassian finally raised its first round in 2010, as a secondary $60M round at a $400M valuation. And now it is a $4B public company. Not too shabby.
So, if you’re about to raise capital to fund new growth, you must make sure you have the basic elements required to achieve capital-induced hyper growth:
1) Your Market Is Big Enough
Make sure there are enough prospective buyers of your solution to support your growth plans. Spare yourself the top-down market sizing (e.g Gartner says our market is $1B growing at 15% a year and we’re aiming for 10% of the market.) Top-down market sizing is meaningless. Top-down predictions of your eventual market share are equally meaningless.
Investors are not impressed by lofty predictions based on top-down math. It smells of inexperience. And don’t for a moment think that you’re more likely to get a higher valuation if you make up unrealistic hyper-growth sales numbers.
Your market size and potential revenue calculations are very simple. Figure out your ideal target buyers. Figure out how many of them exist in your target market. Figure out how many of them you can convert into customers. Multiply that number by your average revenue per customer. Et voilà! That’s how big you can get.
2) Your Service Is Differentiated
Does your product or service truly stand apart? Do you regularly win against your competition? (Small tip: Please don’t fool yourself into thinking that you have no competition. You do. You either don’t know it or you’re ignoring it.)
As a company grows, it becomes more challenging to deliver a competitive advantage as when you were a smaller company. It starts with the founding CEO spending less time with prospects and customers and rolls down the organization. So don’t assume what differentiates your company today will be sustainable without a lot of extra hard work.
3) Your Growth Is Harder & More Expensive the More You Grow
Founders usually think that growing ten-fold from $1 million in revenue to $10 million is as easy as growing from $100k to the first million. It is not. It is ten times harder and quite a bit more expensive.
Revenue growth rarely scales linearly. And growth percentages drop the bigger you get. Acquiring customers gets more expensive over time rather than less. So make sure to temper your growth projections, and double your cost assumptions.
4) Your Capital Efficiency
Only spend more on acquiring more new customers if your cost of customer acquisition is stable and profitable. A dollar spent in acquiring a new customer should generate at least a dollar in recurring revenue (that you collect upfront). If not, then don’t spend more money on sales and marketing until you have figured out how to optimize your customer acquisition cost.
The more money you raise to grow your revenue, the less time you will spend on optimizing your operation and improving your product/service delivery. Always be aiming for organic growth, and only spend more if you have a highly efficient and profitable operation.
And keep in mind that this piece of advice does not preclude you from becoming a unicorn. It is meant to minimize your chance of early failure, and to maximize your chance of building the solid foundations it takes to build a unicorn.